Traders are betting big against gun stocks (RGR, AOBC)

Short sellers are adding to bets that gun stocks will drop.David Becker/Getty Images

A strange and unexpected thing happens to gun stocks after a mass shooting: they go up.

It adds a perverse twist to an already terrible situation, as firearm enthusiasts race to stockpile weapons out of fear that gun control legislation will hamper future purchases.

It also exposes the dirty truth of gun stocks: rather than moving on more traditional fundamental factors, their direction is often largely dictated by developments in the ongoing gun control debate.

That dynamic is playing out right now across the space. After spiking following the recent Las Vegas massacre — which left 58 people dead — stocks of gun producers like Sturm Ruger and American Outdoor Brands (which owns Smith & Wesson) have erased those gains amid speculation that no legislative efforts are imminent.

In fact, the possibility of heightened gun control is viewed as so unlikely in the immediate term that traders are piling into bets that these stocks will continue to fall.

Average shorting activity in the space has jumped by 10% since early July, according to data provider IHS Markit. On a single-stock basis, the firm finds that Sturm Ruger has over 25% of its shares shorted at present time, while Outdoor brands has also seen a “sharp rise” in shorting activity.

“This slump hasn’t gone unnoticed by short sellers, and they have been busy adding to their positions since last November,” saidSimon Colvin, an equity and credit markets analyst at IHS Markit. “Last week’s tragic events did little to dent resolve in the trade, and these two stocks saw the demand to borrow their shares climb to the highest level in over three months.”

The chart below shows just how much short interest — or bets a stock will fall — in American Outdoor Brands has surged in recent days. The uptick is particularly interesting when you consider that the stock is already sitting close to a 2 1/2-year low.

IHS Markit